Pressure intensifies on Kurdish oil exports

The Iraqi Kurdish oil sector, already battered by low prices, has suffered further problems over the past month. The immediate challenge was a three‑week closure of the export pipeline to Turkey, with the threat of more in the future given the conflict in southern Turkey. Meanwhile, producing companies have weakened further and are lowering their production forecasts and, in the case of a UK-listed (but Turkey-headquartered) oil firm, Genel, even field reserve estimates.

The discovery of oil and gas fields in the territory administered by the Kurdistan Regional Government (KRG) has been one of the major developments in Iraq since the 2003 invasion. The region's geology had been largely unexplored under the Baathist regime and the finds over the last decade have been significant. Although KRG claims of up to 45bn barrels of reserves are almost certainly exaggerated, production exceeded 600,000 barrels/day (b/d) in the second half of 2015 and was further boosted by crude from the federally operated fields in Kirkuk, which has been under Kurdish control since June 2014. These resources make independence for the KRG more economically viable, although in the short run clashes with the federal government, which suspended funding of the KRG two years ago in protest at the commissioning of an export pipeline to Turkey, together with low oil prices, have devastated the KRG's budget and damaged the companies developing its fields.

Pipeline problems

In 2014 there was a real threat that advances by the jihadi Islamic State (IS) might threaten the KRG's oil fields and infrastructure. However, the front lines are now a safe distance away and appear to be holding firm. Yet, almost as soon as this security threat receded, the security risk shifted to the export pipeline to Turkey. The revival of Turkey's conflict with the Kurdistan Workers' Party (PKK) last summer, catalysed by IS attacks in Syria and Turkey, has created instability along much of the pipeline's route. This makes it vulnerable to tapping by criminal gangs and politically motivated attacks by Kurds who resent the KRG's close alliance with Turkey.

There were a few brief outages as a result of attacks in 2015, but the most serious outage began on February 16th and lasted for almost a month, with a restart only on March 11th. It is unclear who was responsible for the most recent incident or why the restart took so long. The delay seems to have been a consequence of Turkish security operations against the PKK in the area, rather than the time required for physical repairs. The outage is likely to have cost the KRG around US$350m in revenue, which it can ill afford given that oil is nearly its only source of income and it is already overloaded with debt and arrears. In response, Turkey provided the KRG with US$200m in emergency aid to help, and the KRG has also been generating cash from prepayments for crude deliveries, including an unconfirmed US$300m from a giant oil trading firm, Glencore.

However, almost as soon as the pipeline reopened, the North Oil Company, which operates some of the Kirkuk fields, stopped delivering oil to the pipeline. About one‑quarter of the roughly 600,000 b/d in pipeline exports have been coming from Kirkuk in recent months. It is unclear whether this suspension is being enforced by the federal government in Baghdad, in response to indications that the KRG is formalising its annexation of the Kirkuk field, or by Kirkuk province itself. Kirkuk faces its own fiscal challenges and has not been receiving much revenue from the KRG for its own oil, and, although its governor, Najmaldin Karim, is Kurdish, he has a history of independence (including an unsuccessful bid to be appointed Iraqi president in 2014). Whatever the case, Kurdish security control of Kirkuk means that a restart of these exports is likely to happen soon.

Producers struggling

The oil stoppage has added to the woes of the oil companies presently producing in the KRG. Although production costs in the KRG are extremely low, around US$5/barrel, the companies have not been receiving sufficient revenue to cover their operating costs. This is because the KRG has been keeping almost all of the export revenue, to cover its public-sector salary bill, building up large arrears to the producers, totalling over US$2bn. In September the KRG finally began making monthly payments of US$75m to the producers, shifting this in 2016 to payments based on the terms of their production sharing agreements.

The change in payment terms may reduce the companies' revenues in the short term, but should boost them when oil prices pick up. However, unless there is a significant revival in oil prices and improved security along the pipeline, some of the producers are likely to begin flirting with bankruptcy over the next few years. Their capital investment in the fields has been partly funded through bonds, but they could struggle to repay or refinance these when they mature. The most urgent case is Gulf Keystone Petroleum, a UK-based company that operates the Shaikhan field. It has US$575m in bonds maturing in 2017, and in the meantime it is struggling to keep up with its debt interest obligations. The other major operators, Anglo-Turkish Genel and DNO of Norway, have a few more years before their own bonds mature. However, they are also being squeezed and all three firms have seen their share prices drop by 70‑90% since mid‑2014, limiting their ability to issue new equity to generate cash.

Aside from cashflow problems, there are new concerns about the geology of the Kurdistan fields. Genel issued a reserves update on its main Taq Taq field on February 29th that revised down its "proven plus probable" by 40% to 172m barrels and forecast that production would fall from 80,000 b/d in 2016 to 50-70,000 b/d in 2017. The Genel announcement has prompted concerns about the reserve estimates for other fields.

Even if reserves figures do not change, a lack of cash is squeezing capital expenditure, which could result in production declines. Gulf Keystone said at the announcement of its 2015 results that, without capital expenditure of around US$70m‑90m, production could decline from 37,000 b/d currently to as low as 11,000 b/d in 2017. More positively, DNO, announcing its results on March 17th, said that it expected 10% growth in production over 2016. Overall, the transformation from the situation in 2013 is as remarkable as it is gloomy for the KRG: back in 2013 the KRG was targeting output of 2m b/d by 2020; now, it will be a major challenge just maintaining KRG production at its current level.